Business

Ponzi story offers insight on swindlers, victims

Oh, what a time we live in when fortunes of everyday folks are being wiped away in seconds. And that’s just from honest dealings in the stock market.

Then there are those who would labor to relieve people of their hard-earned money with schemes and scams that just amaze.

The latest financial scandal comes courtesy of Bernard L. Madoff, who is accused of orchestrating a $50 billion Ponzi scheme. Madoff had been a prominent member of the securities industry. He was a member of Nasdaq’s board of governors and served as chairman of its trading committee.

It would not be surprising to read this of Madoff: “Admirers hailed him as a wizard, critics branded him a fraud. Either way, he arrived on the scene at the perfect moment.”

But those are the words Mitchell Zuckoff used to describe the man who set the model for the scheme Madoff is accused of perpetrating: Charles Ponzi. If you have a desire to understand people who engage in financial fraud — and you should — read Zuckoff’s book “Ponzi’s Scheme: The True Story of a Financial Legend.” Now in paperback, “Ponzi’s Scheme” is my pick for the first Color of Money Book Club selection for 2009.

Unsupported structure

A Ponzi scheme is just another way to describe the concept of robbing Peter to pay Paul. Only in this case, money from new investors is used to pay off earlier investors. Eventually, the con collapses when not enough new money is coming in to pay off existing investors.

Madoff, who is facing charges of securities fraud, may have beaten Ponzi at his own game by possibly creating the largest Ponzi scheme in history.

In complaint filings, authorities allege that Madoff informed two senior employees that his investment advisory business was a fraud. Madoff told these employees that he was “finished,” that he had “absolutely nothing,” that “it’s all just one big lie,” and that it was “basically, a giant Ponzi scheme.” The Madoff firm had more than $17 billion in assets under management as of the beginning of 2008, according to regulatory filings.

The Securities and Exchange Commission alleges Madoff conducted a fraud that appears to be of “epic proportions.”

That’s what was said of Ponzi’s scheme after it, too, was finally exposed as a fraud.

In 1920, Charles Ponzi promised a 50 percent return on people’s investments in 45 days. With 18 investors and $1,770, he created a scheme that would eventually rake in millions. At the peak of his scam, his firm collected more than $2 million a week at his office in downtown Boston.

Zuckoff doesn’t glorify or crucify Ponzi. Instead, he’s written an engrossing biography explaining how someone from humble roots could so easily dupe thousands of people.

Ponzi set out to earn a legal profit by creating an investment business that would buy postage stamps called International Reply Coupons, Zuckoff explains. Ponzi had intended to buy coupons at a discount in foreign countries and redeem them in the U.S. for stamps carrying a higher value. The difference in what he paid for the coupons and what they redeemed for would be his profit.

In theory, it was workable. In practice, there weren’t enough coupons in existence and the cost to get them to the U.S. would have erased his profits.

Falling for scams

In researching Ponzi, Zuckoff reveals as much about the victims as the villain.

“Get-Rich-Quick promoters generally take a wholesale approach to generating wealth,” Zuckoff writes. “When critical masses of people have ostensibly prospered, their friends and neighbors come running, setting off a financial frenzy.”

Here’s what I’ve also deduced about why this scam works so well. People are so focused on achieving easy money that they trust without verifying. Others fall for these scams because they are convinced there is a carefully guarded “secret” way to wealth.

Madoff investors believed — some who should have known better — that he could take their money and invest it in an obscure and complicated way to produce year-after-year returns without many, if any, losses.

It’s too early in the Madoff story to know what may have led him to allegedly swindle people, but it’s worth reading Zuckoff’s look at Ponzi’s life. Perhaps it will keep you from falling victim to a Ponzi scheme.

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Comments

Will someone please explain how Social (In)security is not the largest Ponzi scheme ever run in the history of mankind. Doesn't it meet all the Ponzi requirements except legal sanction by governmental authorities?

Bondmen: Exactly. As near as I can tell, legal sanction is the only difference between Social Security and a Ponzi pyramid. Social Security is in danger of collapsing since both wages and the population have stagnated: It is based on the assumption that each generation will be larger and/or better paid than the previous generation.